Shearman And Sterling

January 09, 2023

The FTC Sets Its Sights on Noncompete Agreements, Launches First Major Standalone Section 5 Claims

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THE FTC SETS ITS SIGHTS ON NONCOMPETE AGREEMENTS, LAUNCHES FIRST MAJOR STANDALONE SECTION 5 CLAIMS

Introduction

Last week, the FTC announced two significant moves. First, the FTC brought its first major standalone Section 5 actions,[1] targeting certain companies’ employment noncompete agreements as unfair methods of competition. The very next day, the FTC issued a Notice of Proposed Rulemaking that would ban nearly all employment noncompete agreements in the United States (the “Proposed Rule”). The Proposed Rule is significant in and of itself, potentially invalidating millions of noncompete agreements. Moreover, the complaints and the Proposed Rule reflect a newfound willingness of the FTC to bring standalone Section 5 claims and to issue substantive rules prohibiting certain practices wholesale. We discuss each action in turn.

Section 5 Standalone Claims

On January 4, the FTC filed three complaints, alleging that two glass companies (Ardagh Group and O-I Glass Inc.) and a security company (Prudential Security) had each violated Section 5 by entering and maintaining noncompete agreements with their employees.[2] Broadly speaking, the FTC alleged that: Ardagh’s noncompete agreements prohibited over 700 employees from competing post-employment in the United States, Canada or Mexico for two years; O-I Glass’ noncompete agreements prohibited over 1,000 employees from competing post-employment for one year in the United States; and Prudential Security’s noncompete agreements prohibited its security guards from competing post-employment for two years within 100 hundred miles of their primary job site and imposed a $100,000 penalty for violations.

Simultaneously, the FTC announced it had entered proposed consent orders with the companies, which would ban the companies from entering or maintaining noncompete agreements with most employees for 20 years.[3] Notably, the consent orders banned noncompete agreements for a wide variety of positions (all positions at Prudential, 600 at O-I Glass, and 340 at Ardagh), including both industry-specific and non-industry specific jobs (like lawyers, accountants, etc.). Commissioner Wilson dissented, decrying the lack of evidence of anticompetitive effects, renewing her concern with the FTC’s new framework for evaluating Section 5 claims, and expressing due-process concerns for prosecuting conduct predating the FTC’s change in approach.[4]

These are the FTC’s first standalone Section 5 claims in decades. They are also the first to use the Section 5 analytical framework set out in the November Policy Statement.[5] For example, in finding a violation, the FTC did not define a relevant market, gave little credence to possible business justifications, relied more on the intrinsically “exploitative” nature of noncompete agreements than anticompetitive effects, and focused primarily on the harm to workers (rather than consumers).

The FTC’s newfound willingness to bring standalone Section 5 claims will have an impact far beyond noncompete agreements. On its face, Section 5 is tremendously broad, prohibiting all “unfair methods of competition.”[6] And the FTC has identified numerous other categories that might violate Section 5, like facilitating tacit coordination, loyalty rebates that entrench market power, refusals to deal, acquiring nascent competitors, interlocking directorates, etc.[7]

The Proposed Rule

On January 5, the FTC issued a sweeping Proposed Rule that, if finalized, would categorically ban almost all employment noncompete agreements as unfair methods of competition. Specifically, the Proposed Rule would ban employers from entering, attempting to enter,[8] or maintaining a noncompete clause with a worker, as well as representing to a worker that they are subject to a noncompete clause.[9] “Worker” includes anyone—paid or unpaid, employee or contractor—doing work for an employer, regardless of title or seniority.[10] The Proposed Rule would generally require employers to rescind any existing noncompete agreement within 180 days of the Proposed Rule becoming final and to provide individualized notice to its workers that it had done so.[11]

Importantly, the Proposed Rule not only prohibits noncompete clauses as such, but also de facto noncompete clauses—provisions that have the “effect of prohibiting the worker from seeking or accepting employment with a person or operating a business [post-employment].”[12] For example, confidentiality (non-disclosure) agreements, non-solicitation agreements, no-recruit agreements, liquidated-damages provisions and training-repayment agreements could qualify, depending on their scope and effect.[13] Although not entirely clear, the Proposed Rule likely does not prohibit “garden leave” provisions, which require employees to provide relatively long advance notice to their employers in order to terminate their employment.

There are a few limitations to the Proposed Rule. It applies only to the employment relationship (i.e., between an employer and a “worker”). It exempts persons (with at least 25% ownership) who are selling their business. It does not apply to anyone who is not covered by the FTC Act.[14] And it does not apply to franchisees.[15]

As Commissioner Wilson’s dissent notes, the Proposed Rule “represents a radical departure from hundreds of years of legal precedent.”[16] Although noncompete agreements have long been subject to federal scrutiny, federal courts have typically refused to bar them outright under federal law.[17] Instead, they have considered noncompete agreements on a case-by-case basis, evaluating the reasonableness of a noncompete agreement’s duration, geographic scope, and connection to legitimate business objectives.

That said, some states, like California, have long barred or severely limited the use of noncompete agreements. And in recent years, more states have restricted the use of noncompete agreements, especially as they relate to low-wage employees. Moreover, some of those laws also prohibit non-solicitation clauses. As a result, employers have increasingly faced a patchwork of state laws and enforcement actions.[18]

The Proposed Rule is now open for public comment and could change before it is finalized. In particular, the FTC has indicated that it will consider whether the rule should use a rebuttable presumption rather than a categorical ban, whether the rule should differentiate between different jobs, and whether there should be different standards for senior executives.[19]

The Proposed Rule is almost certain to be challenged; and there is reason to think that it may not withstand judicial scrutiny.

  • As the Supreme Court explained last summer, under the major-questions doctrine, it views an agency’s “assertions of ‘extravagant statutory power over the national economy’ with ‘skepticism.’”[20] In a situation like this one, where an agency seeks to issue a novel and sweeping regulation that exercises substantial political and economic power and that undoes centuries of practice, the Supreme Court requires “clear congressional authorization.”[21] Here, the FTC’s authority to issue substantive regulations banning particular conduct as unfair methods of competition is somewhat unclear.[22]
  • If Congress did authorize the FTC to take such actions, such authorization may violate the non-delegation doctrine (which prohibits Congress from delegating legislative authority to agencies).[23] Indeed, the Supreme Court has already (albeit obliquely) suggested as much.[24]
  • The Proposed Rule conflicts directly with a Seventh Circuit decision holding that noncompete agreements are not per se illegal under Section 5.[25] And it more generally conflicts with “several hundred years of precedent.”[26]

The Proposed Rule, if finalized and allowed to stand, would itself mark a major change in American law. But it also signals the potential for the FTC to target other conduct through rulemaking rather than through enforcement actions.

All in all, although the FTC’s new approach to Section 5 and the Proposed Rule appear vulnerable to challenge, both reveal an aggressive approach from the FTC that will likely target conduct far beyond noncompete agreements.[27] Companies should be cautious and evaluate (1) whether they currently have noncompete (or de facto noncompete) agreements in place and (2) more broadly, whether they have practices that have not been thought to violate antitrust laws but that the FTC may now consider to be “unfair methods of competition.”

Footnotes

[1] Section 5 of the FTC Act prohibits, in relevant part, “[u]nfair methods of competition.” 15 U.S.C. § 45(a)(1). Although sometimes brought with claims under the Sherman Act and the Clayton Act, standalone Section 5 claims have been rare.
[2] In re Ardagh Grp. S.A.; In re O-I Glass, Inc.; In re Prudential Sec., Inc.
[3] Ardagh Grp, Prop. Order, https://www.ftc.gov/system/files/ftc_gov/pdf/2110182ardaghdraftorder.pdfO-I Glass, Inc., Prop. Order, https://www.ftc.gov/system/files/ftc_gov/pdf/2110182o-iglassdraftorder.pdfPrudential, Prop. Order https://www.ftc.gov/system/files/ftc_gov/pdf/2210026prudentialsecurityproposedorder.pdf.
[4] See Dissenting Statement of Comm’r Christine S. Wilson re In re Prudential Sec. (Jan. 4, 2023), available at https://www.ftc.gov/system/files/ftc_gov/pdf/wilson_dissenting_statement_-_prudential_security_-_final_-_1-3-23.pdf.; Dissenting Statement of Comm’r Christine S. Wilson re In re O-I Glass, Inc. & Ardagh Grp. (Jan. 4, 2023), available at https://www.ftc.gov/system/files/ftc_gov/pdf/wilson-dissenting-statement-glass-container-cases.pdf.
[5] Previously, in determining whether something was an unfair method of competition, the FTC used an analysis like the Sherman Act and Clayton Act’s “rule of reason”—seeking to maximize consumer welfare and considering whether a practice had caused an anticompetitive effect, accounting for any offsetting procompetitive effects or business justification. In its November Policy Statement, the FTC indicated it would be departing from this approach. See generally The FTC Abandons (The Rule Of) Reason, Shearman & Sterling (explaining Section 5 and the Policy Statement in detail).
[6] Courts have had little opportunity to interpret Section 5 and no court has precisely identified its limits.
[7] See The FTC Abandons (The Rule Of) Reason, Shearman & Sterling (identifying suspect categories).
[8] This means that, presenting a worker with a noncompete agreement, even if it is not accepted, would be illegal.
[9] § 910.2(a). There is an exception (driven by First Amendment concerns) for representations made in good faith. Id.
[10] § 910.1(f). Consistent with the definition of “worker,” “employment” as used in the Proposed Rule is not limited to common-law employment and covers services as an independent contractor. § 910.1(d).
[11] § 910.2(b)(2)(A)–(B); § 910.5. This requirement also extends to former workers whose contact information is readily available. § 910.2(b)(2)(B). Notably, an employer who provides the required notice is considered to have satisfied the recission requirement (no formal contractual amendment is needed). § 910.2(B)(3). The Proposed Rule includes a safe-harbor model notice for this purpose. § 910.2(b)(2)(C).
[12] § 910.1(b)(2).
[13] Not. 11; see also § 910.1(b)(2)(i)–(ii).
[14] For example, non-profit entities, governmental entities acting in sovereign capacities, certain lending institutions, and certain common carriers. See 15 U.S.C. § 45(a)(2); Not. 112–13.
[15] § 910.1(f).
[16] Dissenting Statement of Comm’r Christine S. Wilson re the Notice of Proposed Rulemaking for the Non-Compete Clause Rule (Jan. 5, 2023), available at https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetewilsondissent.pdf.
[17] See, e.g., United States v. Addyston Pipe & Steel Co., 85 F. 271, 281 (6th Cir. 1898) (Taft, J.) (explaining that employment noncompete agreements “are generally upheld as valid”); Snow v. Align Tech., Inc., 586 F. Supp. 972, 977 (N.D. Cal. 2022).
[18] The Proposed Rule would set a floor, not a ceiling. So, state laws could continue to be more restrictive of noncompete agreements than the Proposed Rule. § 910.4.
[19] Not. 140–53.
[20] West Virginia v. EPA, 142 S. Ct. 2587, 2609 (2022) (quoting Util. Air Regulatory Grp. v. EPA, 573 U.S. 302, 324 (2014)).
[21] Id. at 2608–09.
[22] Compare Nat’l Petrol. Refiners Ass’n v. FTC, 482 F.2d 672 (D.C. Cir. 1973) (concluding the FTC had substantive rulemaking authority), and 15 U.S.C. § 46(g) (“The Commission shall also have power . . . to make rules and regulations for the purpose of carrying out the provisions of this subchapter.”), with Wilson’s Dissent 10–12 (arguing that the required “clear authorization is unavailable”), and § 46(g) (burying authorizing provision in corporate-classification subsection), and Cyan, Inc. v. Beaver Cnty. Emps. Ret. Fund, 138 S. Ct. 1061, 1071 (2018) (“Congress does not ‘hide elephants in mouseholes.’” (quoting Whitman v. Am. Trucking Ass’n. 531 U.S. 457, 468 (2001)).
[23] See Gundy v. United States, 139 S. Ct. 2116, 2121 (2019) (“The nondelegation doctrine bars Congress from transferring its legislative power to another branch of Government.”).
[24] A.L.A. Schecter Poultry Corp. v. United States, 295 U.S. 495 (1935) (upholding Section 5 under nondelegation scrutiny because practices were banned in quasi-judicial proceedings on a case-by-case basis and reaching the opposite conclusion for a law giving the President the power to issue “codes of fair competition”).
[25] Snap-On Tools Corp. v. Fed. Trade Comm’n, 321 F.2d 825, 837 (7th Cir. 1963).
[26] “I am dubious that three unelected technocrats have somehow hit upon the right way to think about non-competes, and that all the preceding legal minds to examine this issue have gotten it wrong.” Dissenting Statement of Comm’r Christine S. Wilson re the Notice of Proposed Rulemaking for the Non-Compete Clause Rule Dissent 3 (Jan. 5, 2023), available at https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetewilsondissent.pdf.
[27] They also signal the Biden Administration’s willingness to use antitrust law to address competition-adjacent perceived social harms (e.g., low wages, unequal bargaining power, etc.).

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